Having studied many professional traders, I found that there are 3 crucial factors that have led to their success. All these market wizards have found success because they have understood and mastered the 3Ms of trading – Method, Money and Mindset.

Method (chart-reading): Process by which a trader enters into the market, using either technical or fundamental inputs to make their decision

To many new traders who know of these 3Ms, they tend to make the mistake of giving equal weightage to all 3 parts (refer to above), or even worse, almost 100% weightage to the “Method”. The most obvious danger is neglect to the other essential parts.

In reality, a professional trader should allocate the 3Ms as depicted below here:

The psychology (mindset) is the hardest part of trading because emotions like greed and fear run wild once your money is at stake in the market. Hence, your degree of rational analysis is only limited to how well you can manage your psychology. Without the execution, the plan is useless. The money and risk management is also essential because it ensures your survival and consistency in the markets. After all, the number one rule is capital preservation.

“Don’t focus on making money; focus on protecting what you have.” – Paul Tudor Jones

Technical Analysis is the study of price patterns and trends in the financial markets so as to exploit those patterns. It is in effect applied mass psychology, for it studies the collective action of all market participants. The classical method focuses on analyzing behavioral patterns and patterns, while the statistical method uses formulas and statistics to find mathematical patterns.

Technical Analysis: The Basics of Reading the Market

In applying technical analysis, the same skills can be applied almost universally across different charts and markets, for example a head and shoulders pattern on a stock chart can be interpreted in a similar way to one one a forex or commodity chart. This is useful if you need an immediate opinion on a market that you know nothing about. The reason technical analysis works so well across different markets universally is because it analyses market psychology, which is the collective psychology of individual market participants.

In contrast with fundamental methods, technical analysis is much less time consuming, for example it can take as little as five minutes to analyse a chart, while doing a valuation on the same stock may take days. This is possible because market technicians believe that market action discounts everything, so instead of trying to figure out the “true” value of a stock by valuation, the technician allows the market to do that for him, by looking at the consensus of all market participants. In addition, technical analysis provides great timing and price projection tools, which cannot be found in the fundamentals.

Technical analysis is part art and part science, which is why both its branches complement each other in analysis. For the classic method, there is some subjectivity involved, since different technicians can interpret the same charts in different ways. In addition, charts cannot be used to predict sudden positive or negative fundamental events, for example earnings, rights issue, M&A. Therefore, it is also importance for technicians to keep track of company news or recent developments, since these act as price catalysts.

Fundamentals and technicals are not mutually exclusive. One way to visualise this relationship is to think of fundamentals as the cause (economic reasons why a stock price moves), and technicals as the effect (the actual moving of the stock price). In the short run, the cause and effect might conflict, and it is almost impossible to attribute the infinite different causes to the observed effects. However, in the long-run, they tend to converge.

Ultimately, investing is a game of probability. Only the insiders in the company know almost everything about the company. For us, who are outsiders, although we may have gathered extensive sources of information on the company, industry, country, we may still be wrong. Thus, it is wise to couple technicals (price consensus of all market participants) with fundamentals (specific knowledge of industry & company) to increase the probability of earning a positive return on your investments.

Technical analysis is used to find opportunities when the probabilities are in your favour, and project possible paths and key levels that prices will reach. It is using past data to make a calculated guess of the future. It is NOT a crystal ball that can forecast the future.

At first glance, trading appears to be very similar to why gambling, which is why many people deem it to be intrinsically risky, with the high possibility of huge loss. However, while there are some similarities, there is actually a major difference between these two activities.

Trading and gambling both involve a certain element of luck and skill, as well as probabilities and uncertainties. Both present the opportunity to make huge amounts of money in a short period of time, and vice versa. That is why both pursuits require good money management skills and strong psychology.

Is Trading really Risky like Gambling?

However, there is one big difference – the edge. Whether you are trading or gambling depends on whether you have the edge. Simply put, this refers to whether probability is on your side. In trading, doing your analysis and taking a calculated risk tilts the probability in your favour, while in gambling, such as in a casino, the odds are always against you.

Before I move on, let me explain the law of large numbers. In statistics, this law states that the larger your sample size (the number of times you trade or gamble), the closer your outcome will be to the expected outcome. If you have the edge, your expected outcome is positive, hence in trading it makes sense to spread out your money over many trades. In gambling, since you do not have the edge, your best bet is to take single large bets, and quit the moment you’re up, but this is also a quick way to lose your capital.

The risk involved is not just the activity itself, but rather the expertise and experience of the person doing it. Professional poker players (who are not gamblers) win because they do not play by luck (gambling), instead they use a system that gives them an edge over other players in the long run. The reason why people lose big in trading is because they take single large bets instead of many small bets, and they trade without a method or system which gives them an edge. This is why position-sizing, capital allocation and risk management are such essential concepts in trading.

Are you making decisions or just guessing?

Some people have asked: Is it possible to make money if one’s hitrate is less than 50%? The answer is yes. If one makes more money when one wins as compared to one’s losses when one loses. This is the idea of the reward/risk ratio, which calculates the upside vs. the downside of every trade. In fact, there are quite a few profitable systems that have hitrates of less than 50%.

In conclusion, the greatest risk is not trading or gambling, but rather the player. Emotions, such as greed and hope, tend to cloud better judgment even when one should know better. Most traders tend to see only the upside in stocks, and not the downside, hence they sell quickly once they see a profit, but hold on to losses in hope that these would turn around. This is the main reason why many traders who have the edge are still unable to grow their accounts.